Lieberman In Good Times - BrookingsDebt Crises, 1815–1914 S ... Ottoman Empire, the...

11

ONE

Historical Context

The Export of Capital and Sovereign Debt Crises, 1815–1914

Starting about 1815, when the Napoleonic Wars ended and the Concert of Eu rope,

or Pax Britannica, was established, the newly industrialized Eu ro pean states began

exporting capital to the periphery.1 Great Britain, the most advanced industrialized

country, led the way but was soon joined by France, Germany, Switzerland, and the

Low Countries.2 By the end of the nineteenth century the United States, until then

the largest borrowing country, also began to export capital, primarily to the Far East

and Latin Amer i ca.3 The pro cess continued throughout the nineteenth century and

the beginning of the twentieth century up to World War I, despite numerous inter-

vening debt defaults by borrowing states, the failure of impor tant financial insti-

tutions, and periodic financial crises. Capital was exported through the capital

markets of the advanced economies largely to sovereign states in the periphery (at

pres ent known as developing or emerging market countries, depending on their

economic status).

Loans also went to great powers, empires, and former empires— Russia, the

Ottoman Empire, the Austro- Hungarian Empire, China, Spain, and Portugal, as

examples— who were often in financial distress. As the century progressed, Great

12 IN GOOD TIMES PREPARE FOR CRISIS

Britain began to concentrate its loans in the areas of recent settlement— Canada, New

Zealand, Australia, and the United States— where the human capital was able to pro-

ductively absorb the financial capital. Fi nally, Britain exported capital to its colonies,

above all India (see tables 1-1 and 1-2). Most of these loans were private, raised in the

London capital market or the Eu ro pean bourses in the form of long- term debt, usu-

ally fifty- year bonds. At times, when countries were in deep distress and the bond

markets unavailable to them, they borrowed via floating debt or short- term loans ar-

ranged by the issue houses, later known as merchant banks.4

During the nineteenth century, defaults on sovereign loans were frequent, par-

ticularly to newly in de pen dent republics in Latin Amer i ca or to Greece and the older

empires. Some sovereign debtors defaulted for an extended time period. Many of these

same debtors were at the heart of sovereign debt crises in the interwar years and the

Great Depression (discussed in Part I of this book). Also, several of these debtors fea-

tured prominently in the debt crises of the early 1980s or the emerging market crises of

the 1990s and early 2000s (Parts II and III of this book), and some featured prominently

TABLE 1-1. British Overseas Investments in Publicly Issued Securities, 1913

Region or areaMillions of

British pounds Percent

Total British Empire 1,780.0 47.3Total Latin Amer i ca 756.6 20.1Total Eu rope 218.6 5.8All foreign countries 1,983.3 52.7Total 3,763.3 100.00

Source: Herbert Feis, Eu rope: The World’s Banker, 1870–1914 (London: Frank Cass, 1936), p. 27.

TABLE 1-2. British Overseas Investments in Publicly Issued Securities,

December 1913, by Category

Class of security Millions of £ Percent

Government and municipal 1,125.0 29.9Railways 1,531.0 40.6Other public utilities 185.1 5.0Commerce and industry 208.5 5.5Raw materials 388.5 10.3Bank and finance 317.1 8.4Total 3,763.3 100.0

Source: Feis, Eu rope: The World’s Banker, p. 27.

Historical Context 13

in the rescue packages or “bailouts” during the crisis of the early 2000s in the euro-

zone (Part IV of the book). Some countries were serial defaulters who lacked

either the capacity or the will, or both, to ser vice their sovereign debts. Greece, Mex-

ico, Argentina, and Turkey (the Ottoman Republic) are prominent examples, but they

are no means alone among frequent defaulters.

The approach to negotiating debt ser vice disruption soon was well established—

creditor committees in the vari ous countries representing the bondholders negotiated

restructuring of their loans on a case- by- case basis, with the creditors often consoli-

dating all loans, reducing interest or principal due, or extending the amortization pe-

riod. The fundamental princi ple was that a debtor in default could not return to the

capital market for fresh capital until its debts were recomposed ( today we would say

resolved or restructured) and the debtor was servicing its debts. The approach to re-

solving debt ser vice disruption set a pre ce dent for the sovereign crises discussed in

subsequent parts of this book. This chapter provides background for the chapters that

follow.

Capital export took place through the intermediation of capital market issues on

the stock exchange in London and vari ous Eu ro pean bourses, which became the cen-

ters for issues of international shares and debentures. These investments were held

largely by private investors, as were the two earliest forms of debt securities issued to

the public via the market, consols and rentes.5 As the nineteenth century progressed,

merchant banks, sometimes referred to as issue houses, which arranged the initial

stock exchange listings for debentures or share issues, took on an underwriting role.

They were followed by joint- stock banks (which made direct loans or directly assumed

investments), by trusts, and by other investment institutions, all of which achieved a

more prominent position in international investing as the century progressed.6 While

the capital markets in each of the primary creditor countries— Great Britain, France,

Germany, and the United States— developed in dif fer ent ways, the main actors

throughout this period were in the private sector.7 Government loans and govern-

ment guarantees were rare.8

Two types of conclusions may be drawn from the history of capital export dur-

ing the period 1815–1914 with re spect to the primary focus of this book, sovereign

debt crises and their resolution from the Great Depression to the Great Recession.

The first set of conclusions is economic in nature. The second set concerns capital

export and the po liti cal economy and international relations during sovereign crises.


Economic Conclusions

Loans were initially provided by the London capital market and as the century pro-

gressed by France and Germany and a number of the traditional Eu ro pean creditors

through their bourses in Amsterdam, Frankfurt, and Zu rich (see tables 1-3, 1-4,

and 1-5).

Hard- Core Creditors and Their Capital Markets

During this era, 1815 to 1914, a small, “hard- core” group of creditor countries and

capital markets emerged as the primary sources of capital export. Financial instru-

ments were primarily long- term bonds floated on the London market and vari ous

Eu ro pean bourses and subscribed to by private investors. Export capital was inter-

mediated in London, Paris, Frankfurt, Zu rich, and Amsterdam primarily by the mer-

chant banks, which were also deeply involved in trade finance. Later in the century

the German “ great banks” played a strong role in international finance as Germany

increasingly emerged as a great power and competed with Great Britain and France

in trade, in railway development, and for colonies (see tables 1-4 and 1-6). Capital

export went to countries without their own or with weak capital markets.9

Toward the end of the century up to World War I, New York emerged as a source

of credit to the periphery, particularly Latin Amer i ca,10 and the New York invest-

ment banks rivaled their competitors in London. In the interwar years New York

assumed the mantle as the leading world capital market. Thereafter the bond mar-

kets in New York and London, to a lesser extent the other Eu ro pean bourses, and

eventually Toronto, Tokyo, Hong Kong, and offshore con ve nience centers such as the

Cayman Islands constituted the major source of capital export to the rest of the world

in the post– World War II era and the emerging markets crises of the 1990s.11

The issue houses of this period, the private banking concerns that evolved into

merchant and investment banks during the nineteenth century, are the key players

in the current eurobond market. Moreover, the money center banks, the successors

to the Credit Mobilier movement in France, the German great banks, and the con-

centration of banking in Eu rope after 1870 resulted in the formation of the large joint-

stock banks,12 which are now, with the addition of the major U.S. money center

banks, the market makers in the eurocurrency market. These banks were responsible

for most of the syndicated lending to the developing and emerging market countries

during the 1970s and 1980s in the leadup to the 1980s debt crisis.

The recent crisis, known as the Great Recession (from 2007 to 2010 in the United

States and from 2009 to 2015 in the eurozone), is anomalous in the post– World War II

TABLE 1-3. French Foreign Investment, as of 1914

Country or regionThousands of

millions of francs Percent

Rus sia 11.3 25.1Turkey 3.3 7.3Spain and Portugal 3.9 3.7Austria- Hungary 2.2 4.3Balkan states 2.5 5.5Rest of Eu rope 1.5 3.4 Eu rope total 27.5 61.1French colonies 4.0 8.9Egypt, Suez, and South Africa 3.3 7.3United States and Canada 2.0 4.4Latin Amer i ca 6.0 13.3Asia 2.2 5.0 World total 45.0 100.0


TABLE 1-4. German Foreign Investment, as of 1914

Country or region Billions of marks Percent

Austria- Hungary 8.0 29.3Russia 1.8 6.6Balkan countries 1.7 6.2Turkey (including Asiatic Turkey) 1.8 6.6France and Great Britain 1.3 4.8Spain and Portugal 1.7 6.2 Eu rope total 16.3 59.7Africa (including German colonies) 2.0 7.3Asia (including German colonies) 1.0 3.7United States and Canada 3.7 13.6Latin Amer i ca 3.8 13.9Other areas 0.5 1.8 Outside of Eu rope total 11.0 40.3Total 27.3 100.0



era as a throwback to the Great Depression of the 1930s. The crisis was primarily

centered on the large money center banks and the financial markets, the historically

traditional sources of capital to the rest of the world. The economic crises that have

followed the financial crises were centered largely in the advanced industrial econo-

mies starting in Japan in the 1990s, followed by the United States in 2007, then Japan

again and the eurozone whose respective economies were characterized by low growth

and low to near deflationary conditions. Japan and the United States, two of the major

creditor states, are now substantial sovereign debtors, as is China.13

TABLE 1-5. German Foreign Investments, as of 1908, by Category

Class of securityMillions of 1914 marks Percent

Provincial and municipal 700 2.4Mortgage bonds 1,087 3.8Bank shares and debentures 384 1.3Railway shares 2,681 9.2Rail debentures 3,929 13.6Industrial shares and debentures 281 1.0Total 28,958 100.0

Source: J. Riesser, The German Great Banks and Their Concentration in Connection with the Economic Development of Germany, 3rd ed. (Washington: Government Printing Office, 1911), pp. 392–93, citing Statisches Jahrbuch fur das Deutsche Reich, Vol. 29 (1908), p. 228. Translated for Hearings of the United States Congress, National Monetary Commission, 61st Congress, 2nd session, Document No. 593. First published as Die deutschen Grossbanken und ihre Konzentration (1908).

Note: Included in this nominal amount of approximately 29 billion marks is 8.2 billion marks of conver-sion issues, of which 6.6 billion represent conversion on state loans.

TABLE 1-6. Main Creditor and Debtor Countries, as of 1913

Gross creditorsBillions of US$ Percent Gross debtors

Billions of US$ Percent

United Kingdom 18.0 40.9 Eu rope 12.0 27.3France 9.0 20.4 Latin Amer i ca 8.5 19.3Germany 5.8 13.2 United States 6.8 15.5Belgium, Netherlands, and

Switzerland5.5 12.5 Canada 3.7 8.4

Asia 6.0 13.6United States 3.5 8.0 Africa 4.7 10.7Other countries 2.2 5.0 Oceania 2.3 5.2Total 44.0 100.0 44.0 100.0

Source: United Nations, International Capital Movements during the Inter- War Period (Lake Success, N.Y.: United Nations Department of Economic Affairs, 1984), p. 2.


Hard- Core Debtors and Their Reliance on External Capital

Joining the hard- core group of creditors was a hard- core group of debtor states in

the periphery. Some, particularly those in the areas of recent settlement— the United

States, Canada, Australia, and New Zealand— emerged as creditors toward the end of

the era or as a result of World War I. These states were generally unencumbered by

rigid po liti cal and social systems, while benefiting from a transfer of human capital

attributable to immigration.14 However, relatively few states absorbed their external

debt well, and, after a series of cycles of default and renegotiation, they emerged as

hard- core debtors. This pattern was most pronounced in the Latin American states,

the Ottoman Empire (Turkey), Egypt, Greece, Spain, Portugal, Rus sia, and the

Balkan states15 (see table 1-6 above). At pres ent, several of these or their successor

states rank among the major debtor nations, with Mexico, Argentina, Rus sia, and

Turkey needing to be bailed out during the emerging market crises in the 1990s

and early 2000s and Greece and Portugal needing to be bailed out during the euro-

zone crisis.

During the nineteenth century, the peripheral states, with their weak domestic

capital markets and undeveloped banking systems, were reliant on external loans

for industrialization, particularly capital- intensive infrastructure investments such

as railways and utilities.16 In addition, states borrowed to cover per sis tent bud get

deficits. Often their rulers failed to distinguish between their own purse and that

of the state. With their narrow fiscal bases, external capital markets were tapped

to provide additional resources for governments. This reliance has not changed

markedly today.17

Expensive Loans to Peripheral States Reflected Perceived Credit Risks

Bonds floated on the bourses of Eu rope usually had long amortization periods, which

matched the capital intensiveness or “lumpiness” of the investments made in railways

and other infrastructure proj ects. However, these loans were expensive. Real rates of

interest were high: the nominal interest rates of 5 percent and 6 percent for the pe-

ripheral states were doubled through the deep discounting of bonds, a deduction of

one to two years of debt ser vice in advance, and heavy commissions paid to the issue

houses. In addition, railway concessions often required state- guaranteed returns or

revenue per mile of track laid, as well as land grants, all of which added to the ex-

pense of these loans (see table 1-7).18


Excessive Short- Term Borrowing (Floating Debt) Signaled Debt Crisis

When states were unable to float bonds during cyclical downturns in the market or

when their creditworthiness had declined, they resorted to short- term borrowing in

excess of trade requirements. This floating debt was a sure sign that a debt crisis or

default was at hand.19

High real rates of interest on variable rate commercial bank loans and a concen-

trated buildup of short- term loans in excess of reserves was characteristic of the 1980s

debt crisis and the emerging market crises of the 1990s. The short- term borrowing

and very high leverage of the shadow banks leading to the U.S. crisis (2007–10) also

triggered financial economic crises in the United States and Eu rope, particularly in

the eurozone.

Defaults, Recurring and Sustained

The relatively frequent defaults during this period were concentrated among the

hard- core debtors— Greece, Mexico, Argentina, the Ottoman Empire (Turkey), and

Austria, as examples. During the Bolshevik Revolution, Rus sia was the primary case

of sovereign repudiation, on ideological grounds. During the U.S. Civil War the

southern U.S. states, financed by British merchants against cotton exports, also

defaulted on their debts and the federal government thereafter refused to recognize

those debts. Defaults tended to recur and at times were longlasting. At the heart of

defaults, subsequent debt negotiations, and resolution are two primary issues: the ca-

TABLE 1-7. Realized Rates of Return on Capital Export, 1870–1913

Percent

Category 1870–76 1877–86 1887–96 1897–1909 1910–13

Consols 3.59 3.76 4.13 0.93 −0.37French rentes 4.79 5.41 5.55 2.73 2.34Colonial and provincial

governments6.08 4.72 4.95 2.78 1.77

Indian railways 4.63 4.70 6.01 0.74 2.36U.S. railways 7.84 7.69 4.63 6.13 2.08Latin American railways 5.96 7.04 6.77 4.09 1.73Social overhead investment 0.00 0.00 5.20 3.70 2.55

Source: Michael Edelstein, Overseas Investment in the Age of High Imperialism: The United Kingdom, 1850–1914 (London: Methuen, 1982), pp. 153–54, table 6.30.


pacity of states to pay versus their will to pay. John Maynard Keynes, in a commentary

on capital export and defaults, voiced a general distrust of foreign lending based on

the experience of the nineteenth century:

Indeed, it is probable that loans to foreign governments have turned out badly

on balance— especially at the low rates of interest current before the War. The

investor has no remedy, none what ever against default. There is, on the part

of most foreign countries, a strong tendency to default on the occasion of wars,

revolutions and whenever the expectation of further loans no longer exceeds

in amount the interest payable on the old ones. Defaults are world- wide and

frequent.20

At times during the nineteenth century the negotiations extended over many

years. In the interwar years many countries defaulted from 1931 to 1933 during the

Great Depression and remained in default until after World War II, with debts still

being settled twenty or so years after the end of World War II. Similarly, after the 1980s

debt crisis the major debtors— Mexico, Argentina, Brazil, and others— renegotiated

repeatedly with their bank creditors from 1982 to 1994.

During the emerging markets crisis of the mid-1990s and early 2000s, Argen-

tina was in crisis and defaulted in 2002. Argentina then negotiated its debts with

bondholders over an extended period of time; it agreed to a punitive and partial

settlement with the bondholders, bordering on repudiation, in 2004 and again in

2010. Argentina’s default was fi nally settled after extensive litigation with minor-

ity creditors in the first quarter of 2016. Greece went into default in 2010 and has

since experienced three bailouts and a major po liti cal crisis. The bailouts have not

solved the prob lem of its overindebtedness or restored Greece to a sustainable

growth path.21

Renegotiation between a Debtor and Its Creditors

Relatively few defaults ended in repudiation, as it was in the interest of both debtors

and creditors to renegotiate. Creditors sought to preserve their principal and eventu-

ally see full debt ser vice restored, while debtors sought to regain their creditworthi-

ness and access to the external capital markets of Eu rope. Renegotiation reflected a

delicate balance of power between creditor and debtor: the former denied loans to

debtors in default via closure of their capital markets and other forms of pressure,

including diplomatic repre sen ta tion, while the latter maintained moratoriums on


their debt ser vice until a satisfactory restructuring was achieved. Renegotiations

and restructurings were thus common throughout the period.22

All restructurings in the nineteenth century were handled case by case. Credi-

tors initially negotiated with a sovereign debtor through separate bondholder com-

mittees formed to handle a default on a single loan. Over time, country committees

were formed and eventually incorporated as the Corporation of Foreign Bondhold-

ers in England and its continental equivalents. In England the Council of the Cor-

poration coordinated the efforts of the individual committees and brought the weight

of the City of London to bear on a sovereign debtor in default, as well as encourag-

ing diplomatic repre sen ta tion from the foreign office in difficult cases. This prac-

tice was emulated in Eu rope, with the vari ous national bondholder committees

cooperating to avoid competitive settlements and to maintain maximum leverage

over the debtor.23

During the 1980s debt crisis, bank creditor committees, chaired by the major

money center banks, negotiated restructurings case by case, a clear parallel with the

nineteenth- century experience. This practice of case- by- case restructuring continued

during the sovereign crises in the 1990s, such as in Mexico (1994–95), East Asia (1997–

2003), Rus sia (1998), Turkey (2001–02), and Argentina (2001–03). However, restruc-

turing support was provided by the IMF, World Bank, and G-7 acting as inter-

national lenders of last resort during the crises in the 1990s and early 2000s. In the

eurozone crisis individual country bailouts were handled on a case- by- case basis in

Greece (beginning in 2010 through 2015), Ireland (2010–14), Portugal (2010–14), and

Cyprus (2013) under the auspices of the troika of the Eu ro pean Investment Bank

(ECB), the Eu ro pean Commission (EC) and the IMF, which served as lenders of last

resort and also provided oversight over crisis reforms.

In the major financial and economic crises in Japan, the United States, and Eu-

rope, where sovereign bailouts were not required, the primary central banks— the

Bank of Japan, the U.S. Federal Reserve Bank (the Fed) supported by the Trea sury

and Federal Deposit Insurance Corporation (FDIC), the Bank of England, and the

ECB— served as domestic lenders of last resort but also cooperated with each other,

as well as with other central banks throughout the world, to prevent a wider bank-

ing and financial markets crisis. The U.S. Fed extended currency swap lines to the

major central banks noted above, as well as to the central banks of Switzerland, Mex-

ico, Brazil, South Korea, and Singapore. In total the Fed had swap arrangements

with some fourteen central banks around the world.24


A Flexible Approach to Restructuring

During the nineteenth century there was flexibility in resolving the debt crises. For

example, debt ser vice arrears were frequently capitalized and subject to low escalat-

ing rates of interest over time; interest rates on the original principal were reduced if the

prevailing market rates were lower than the bond coupon rate; debt was consolidated

and unified into relatively few classes; debt ser vice was tied to a percentage of import

and/or export duties, to earnings from an impor tant export crop such as coffee or rub-

ber, or to state monopolies over tobacco or spirits; and bonds were converted to stocks or

equity in newly formed railway concessions. Creditors recognized that there was a cost

to default that would be borne by both debtor and creditor, and solutions had to reflect

the debtors’ capacity to pay in order to be at all workable. Nevertheless, even with those

more pragmatic approaches to restructuring, recurring defaults were not avoided.25

The large external debt overhang that remained throughout World War I and the in-

terwar period was subject to massive defaults in the Depression beginning in 1931.

Most of these defaults were renegotiated and settled following World War II.

In the 1980s crisis, after extensive and difficult negotiations between a sovereign

debtor and its banks as creditors, the U.S. government stepped in, initially to ensure

that its major money center banks with heavi ly concentrated exposure to Latin Amer-

ican debt were protected, but also to resolve protracted sovereign debt crises through

the Baker and Brady Plans (named for U.S. secretaries of the Trea sury James Baker

and Nicholas Brady); the latter emphasized partial debt forgiveness for debtors that

resolved their defaults. Each of these resolutions was handled on a case- by- case basis.

Calls for generalized, rather than case- by- case, solutions for debt forgiveness or mar-

ket buyback of debt on a discounted basis were usually rejected by the creditors and

their governments and went nowhere.26

The IMF and the World Bank played impor tant roles as lenders of last resort in

the 1990s emerging market crises. The IMF served as the primary lender of last re-

sort supported by the World Bank, regional development banks such as the Asian

Development Bank for Korea, and the G-7 countries. The idea was to develop suf-

ficiently large packages on a case- by- case basis so that they were credible in interna-

tional financial markets.

In the crisis that began in 2007, sovereign debtors in difficulty in the eurozone

were supported by the troika— the ECB, the Eu ro pean Commission, and the IMF.

For the first time in a crisis in the advanced industrial countries, the IMF was called

in to play a major role in crisis resolution. Each of the bailout packages was negotiated

and monitored individually. Each one required unan i mous approval by the other eu-

rozone countries.


Losses from Defaults

The losses from defaults during the period under discussion (1815–1914) are difficult

to evaluate. However, a conservative estimate based on repudiations, conversion of

interest to lower rates on arrears and original principal, and conversion to scrip from

hard currency debt on British bond holdings up to 1914 generated losses estimated at

one third of the cumulative defaults during the period, but only 7 percent of the for-

eign bonds issued on the London Stock Exchange during this same period.

French losses were much higher owing to the Rus sian repudiation in 1917 dur-

ing the Bolshevik Revolution. Since most bonds issued between 1815 and 1914 were

fifty- year bonds (amortized over fifty years), the real losses far exceeded the histori-

cal estimates made at the con ve nient stopping point used by most analysts of the pe-

riod, World War I. The overhang of nineteenth- century debt to the interwar years

through the Great Depression and World War II led to losses far greater than the

nineteenth- century estimates. As a result of the two World Wars and the Great

Depression, Great Britain and France lost most of their portfolios. Germany of course

was saddled with reparations after World War I and became a debtor state; and the

United States, now the major creditor country, took losses on commercial loans to

Latin Amer i ca and on inter- Allied war loans. Thomas Piketty notes that British

and French portfolio losses after the Great Depression, the two World Wars, and

the loss of colonies were very substantial: “In the wake of the cumulative shock of

two world wars, the Great Depression and de- colonialization these vast stocks of

foreign assets would eventually evaporate. In the 1950s, both France and Great Britain

found themselves with net foreign asset holdings close to zero.”27

In more recent times, the large money center banks reached settlements with their

major debtors and took partial writedowns of their loans. Argentine bondholders

were forced to live with significantly discounted returns from negotiated settlements

in 2004 and 2010. In 1998 and 1999 the major Rus sian banks defaulted on and even

repudiated some of their loans from their Western creditors. Creditors absorbed ini-

tial losses from the Greek bailouts, but ultimately it is unknown what the losses will

be on Greece’s substantial sovereign debt outstanding. It is a reasonable assumption,

given the state of the Greek economy and its proven difficulty mobilizing tax receipts

and effecting structural reforms such as privatization, that the eventual writedown

of Greek debt will be very large. In the bailout of Cyprus even deposit holders (largely

Rus sians who had parked money offshore) were “bailed in” and forced to suffer losses

(discussed in greater detail in parts III and IV herein).

Fi nally, there are Japa nese government bonds and U.S. Trea suries with gross sov-

ereign debt at 240 percent and 100 percent of GDP, respectively. Since virtually all of


the Japa nese debt is held by individual Japa nese investors and individuals, there ap-

pears to be no immediate threat of a sovereign default. U.S. debt is mostly held by

U.S. investors and institutions, though other governments such as the Chinese and

other East Asian exporters holding large reserves in dollars make the United States

somewhat more vulnerable, in princi ple, than Japan. However, the U.S. dollar re-

mains the world’s major trade and reserve currency, and it strengthened against the

euro and yen during the Great Recession. To date, when there has been a flight to

quality from emerging market countries, it has been primarily to the U.S. dollar.

However, because both Japan and the United States have elevated sovereign debt, both

are vulnerable to a future shock and/or a change in sentiment or loss of confidence

in their respective currencies, and their debt trajectories are not sustainable (see

Part IV).

International Relations Aspects of Capital Export

Although the economic aspects of capital export during the nineteenth century have

received substantial attention, the link between external debt and international rela-

tions is for the most part not adequately addressed.

Capital Export and State Power

From the viewpoint of the creditor states, capital export has to be seen as a projec-

tion of state power in its broadest sense: “The export of capital has in recent times

been a familiar practice of power ful states. The po liti cal supremacy of Great Britain

throughout the nineteenth century was closely associated with London’s position as

the financial center of the world.”28

Not only did Great Britain proj ect its power via capital export to the periphery,

so did France in loans to its continental allies, most notably to Rus sia as a way to

counter the growing power of Germany, and in loans to Tunisia and Morocco as a

way to extend its sphere of influence in North Africa. Germany backed its primary

ally on the continent, Austria- Hungary, and sought to proj ect itself as a major power,

following unification in 1870, in a number of peripheral states. The German great

banks, guided by the chancellor, were the vehicle for Germany’s growing industrial

power and increased penetration of overseas trading markets, largely in competition

with Great Britain.

Even Rus sia, a major debtor, sought to extend its influence in Persia and China

via loans. In the beginning of the twentieth century, the United States, still a major


debtor, demonstrated its role as a growing power by supporting capital export to sev-

eral Central American and Ca rib bean states. All the powers contested with each

other for po liti cal and economic spheres of influence in China via loans, until the cred-

itors curtailed this competition.

Creditor states such as France and Germany maintained direct control over their

capital markets, while the British government maintained close but unofficial ties to

the financial community in the City. Moreover, in Great Britain, legislation was used

to channel loans to India after 1857.

State Intervention and Debt

When the powers sought to maintain the balance of power or the in de pen dence of

newly created states, they intervened directly via loan guarantees, as in Turkey,

Greece, and Egypt. Some authors on imperialism, such as Hobson, Hilferding,

and Lenin, argued that the creditors— that is, cap i tal ist states— were pushed into

imperialism by finance or mono poly capital.29 This view does not appear to be sup-

ported by the facts. These states acted in what they perceived as their higher po liti-

cal and strategic interest and often clouded their actions in a veil of financial

maneuverings.

Direct intervention by the creditor states over defaults was relatively rare. How-

ever, where strategic interests were involved, defaults served as a con ve nient pretext

for intervention, as, for example, by Britain in Egypt, France in Morocco, or the

United States in the Dominican Republic or Panama. More frequently, the creditor

states tried indirect intervention, such as international control commissions, banking

consortiums, or customs authorities. These institutions, which amounted to enclaves

of creditor control, were used in Greece, Turkey, Egypt, China, the Dominican Re-

public, Haiti, and Nicaragua to assist the debtor states in reor ga niz ing their external

debt, to maintain control over sources of revenues dedicated to debt ser vice, and to

report extensively on the economic and po liti cal status of the debtor.

In the case of post– World War II defaults on public credits such as trade credits

insured by bilateral export finance institutions, sovereign debtors are required to re-

negotiate their debts with their creditors through the Paris Club, with the IMF in

attendance to report on the debtors’ economic prospects. During the 1970s and

1980s, Paris Club negotiations were frequent and recurring, as many of the poorer

developing countries found it difficult to ser vice their debts. During the 1980s debt

crisis, sovereign debtors frequently renegotiated their Paris Club debts in parallel

with their commercial bank loans.


In recent debt crises the creditor states have used the multilateral financial

institutions— the Bank for International Settlements (BIS), the International Mon-

etary Fund (IMF, the International Bank for Reconstruction and Development

(World Bank), and regional development banks such as the Asian Development

Bank, supported by backup facilities from the G-7 countries, to support countries in

crisis— for example, during the East Asian crisis. The objective was to keep debt re-

structurings and negotiations po liti cally “neutral.” During the the eurozone crisis as

noted, the troika provided most of the support in the so- called bailouts of Greece, Ire-

land, Portugal, and Cyprus. However, the bailout of Greece took the low politics of

debt to high politics as the newly elected government from the socialist party Syriza

threatened default and exit from the eurozone, while Greece’s creditors, notably

Germany and other northern tier countries, took a hard line on the writedown of

debt and at some point threatened or seemed to favor a Greek exit from the eurozone.

During the nineteenth century, in cases of default where strategic interests were

not involved, creditors often sought the assistance of local consuls in making diplo-

matic repre sen ta tions to debtor governments. These repre sen ta tions, often made

jointly by all the creditor powers, were perceived as direct interventions by the weaker

states of the periphery. In addition, governments would intervene when violations of

international law occurred, such as default on a loan guaranteed by the creditor gov-

ernment, alienation of the collateral hypothecated to one loan, or servicing of domestic

debt in preference to external debt. A default per se was not a violation of interna-

tional law.

International Law and Debt Intervention

The Calvo Doctrine maintained that the powers discriminated against the weaker

states in their interventions and rarely exhausted their remedies under national law

before intervening. The Drago Doctrine, pronounced in the wake of the Venezue-

lan intervention, viewed all interventions over pecuniary claims as immoral and illegal

under international law. The Latin American states, often the objects of interven-

tion, sought to define “American international law” on debt interventions, eventu-

ally bringing this issue to the second Hague Convention of 1907. The convention

expressed a preference for nonintervention and for arbitration over armed interven-

tion. However, the powers refused to rule out intervention in cases of arbitrary and

discriminatory treatment of their nationals as creditors. Overall, however, from the

turn of the century until World War I, attitudes and customary practices in inter-

national law related to defaults evolved away from intervention.


Many developing country debtors, however, view the IMF or the combination of

the IMF and World Bank as anything but po liti cally neutral, since loans from these

institutions are often conditional on economic reforms to be undertaken by the

borrowers. In the late 1980s and 1990s the view was that globalization, including

financial sector liberalization, was based on the Washington Consensus promoted

by the United States, Great Britain, and other Eu ro pean countries, the major share-

holders of the IMF and World Bank, and strongly endorsed by the management

and staff of the IMF and World Bank. Joseph Stiglitz, among others, sees the push

toward rapid globalization, especially the support of financial sector liberalization by

the IMF and World Bank, as an impor tant contributor to the emerging market cri-

ses of the 1990s and early 2000s (as discussed in Part III of this book).30

Trade and Capital Export

Another impor tant component of capital export was trade and commercial relations.

Trade, an impor tant ele ment of economic policy, was intimately tied to the export of

capital, as the powers competed via loans to gain concessions in the peripheral states

seeking to industrialize, and to supply them with capital equipment and other fin-

ished goods and ser vices. Britain’s initial recognition of the Latin American repub-

lics was embodied in a series of commercial treaties. Competition over the Baghdad

Railway proj ect and other concessions in Turkey opened that country to loans and

prob ably accelerated the demise of the Ottoman Empire. All the powers vied for con-

cessions and trade with China, using loans as a means of securing trading enclaves

and spheres of influence.31

External Loans as a Basis for State Sovereignty

Viewed from the perspective of the borrowing states, external loans provided the re-

sources for action. Initially, many smaller countries such as Greece, the Balkan

states, and the Latin American republics sought loans to secure and maintain their

in de pen dence. Newly established states then needed to pay off the external debt they

inherited, as was the clearly established practice in the international law of state suc-

cession. The successor states to the Ottoman Empire, the Austro- Hungarian Em-

pire, the Central American Republic, and Colombia all acquired external debt in this

way.32 In recent times, Rus sia and the other states of the former Soviet Union negoti-

ated over debts of succession and the retention of assets by these countries, such as

Aeroflot’s fleet and factories of large Rus sian enterprises located in the former states

of the Soviet Union.33


Debts Arising from Wars, Indemnities, and Pecuniary Claims

States borrowed to finance wars. The Balkan states, Turkey, Rus sia, and China all

borrowed extensively to prepare for, engage in, or pay indemnities resulting from war.

If, as Raymond Aron writes, peace is the other side of war, or if the dictum “in peace

prepare for war” is accepted, then it follows that a substantial amount of debt was

acquired to prepare for or engage in war.34 At pres ent, a hidden component of the

external indebtedness of many states is expenditures for armaments.

In the current era the United States fought two wars— Afghanistan and Iraq—

that were not formally in the bud get approved by Congress; and the country spends

more on defense annually than the next eight countries collectively. The wars and

continuously heavy spending on defense have added significantly to the United States’

sovereign debt prob lem.

Civil wars and internal strife in the peripheral states also created a demand for

loans, as well as pecuniary claims resulting from damage to the property and lives of

citizens of the major powers. The Southern states of the United States, individually

and collectively the Confederate states, repudiated their debt acquired before and dur-

ing the American Civil War. The Mexican intervention was occasioned in part by

the pecuniary claims of the powers and resulted in Mexico’s repudiation of the Max-

imilian Debt following the French occupation. The Venezuelan intervention was

largely over pecuniary claims arising from civil strife and revolution. China was forced

to borrow to pay indemnities arising from the Boxer Rebellion. Perhaps the classic

case of borrowing to pay indemnities claimed by citizens of the Eu ro pean powers

under extraterritorial privilege was Egypt.35

Developmental versus Revenue Borrowing

Although states in the periphery were potentially able to absorb external loans for

major investments, such as railways, their borrowing for nonproductive purposes such

as wars or to cover bud get deficits inevitably led to defaults. The states in the periph-

ery, with weak capital markets and narrow fiscal bases, often saw their economies

buffeted by po liti cal events. The Ottoman Empire, the Austro- Hungarian Empire,

Spain, Portugal, China, and most of those in the Ca rib bean were untouched by mean-

ingful social and po liti cal change and were unable to absorb capital productively. It

could be argued that borrowing forced a certain amount of opening up in these em-

pires that accelerated their disintegration. Japan, in contrast, a non- Western society,

was able, following the Meiji Reformation, to utilize external capital effectively and

industrialize rapidly. Japan later borrowed extensively through the intermediation of


the New York investment banks and the New York bond market to support impe-

rial expansion in Manchuria.

The Vital Interests of States versus the Sanctity of Contracts

In the nineteenth century, governments of the peripheral states faced a difficult bal-

ance between the sanctity of contracts, pacta sunt servanda, the basis of all contract

law, and the vital interests of their states under changing conditions, or clausula rebus

sic stantibus. In extreme crisis, states chose to default. Many hard- core debtor states

during this period found themselves locked into a vicious cycle of default, renegotia-

tion and restructuring, and subsequent default that elevated finance from low to high

politics. External debt was inevitably linked to other international issues. Argentina,

Mexico, and Greece are examples of such states in the current era.

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